Thursday, January 26, 2012

Testing the Logic of "Fairness" in Taxes

Let’s test President Obama’s logic on tax “fairness” with a simple example.

·Person A makes $50,000,000 a year and pays $7,500,000 a year in taxes

·Person B makes $100,000 a year and pays $30,000 a year in taxes

For the sake of discussion, let’s assume both individuals take advantage of government services in roughly the same way - both will draw the same social security benefits and Medicare eligibility at retirement, use roads, rely on police, fire departments and our military to feel safe at home.In fact, you could make the case that Person A takes advantage of less government services as they might send their children to private schools instead of public, they won’t require a publically subsidized mortgage through Fannie, Freddie or FHA, etc.

So the question is whether it’s fair for Person A to pay $7,500,000 for those services, and Person B to pay $30,000 or 0.4% of what Person A pays for those same services.

According to the wisdom of President Obama, Occupy Wall Street and the Democratic Party, fairness is determined in relation to the percentage of income paid in taxes, rather than absolute dollar amounts.Therefore they argue that this situation is completely and utterly unfair because Person A pays an effective rate of 15% while Person B pays an effective rate of 30%.The fact that Person A paid $7,500,000 and Person B paid $30,000 is irrelevant, in fact, Person A should pay $15,000,000 in the name of fairness.

Others believe this view is a vast oversimplification of a complex problem. But they may also believe that we shouldn’t raise anyone’s taxes because our government is already too big. We need to first cut spending to reasonable levels and then determine the best way of paying for the resulting lean and efficient government.They may also believe that ignoring the difference between income earned through labor and income earned through investment overstates the supposed “unfairness.”

We’ve written about fairness numerous times on thesepages, and in a couple of op-ed's this week (here and here), the Wall Street Journal explains the reasons why investment income should be taxed differently than wage or labor income better than we ever could.

Ultimately, it’s a lazy populist sound bite to say the rich aren’t paying their fair share. If one’s contribution to society is based purely as a percentage of the amount of income earned, then why don’t we just change the pricing of all goods and services to a percentage of income?For example, to make sure that the pricing of a chicken nugget happy meal is “fair”, the current sales price of $5 would only apply to someone making the median income of roughly $30,000 a year.Person A, who makes 3.3 times the median income, would be required to pay $17 for the Happy Meal, and Person B, who makes 1,700 times the median income, would pay $8,400 for the Happy Meal.This also means that a huge portion of the population will get their Happy Meals for free.